What does a floating rate system imply about exchange rates?

• A. They are fixed for long-term contracts
• B. They are set by government regulation only
• C. They may have a target amount set by a central bank
• D. They are entirely predictable

Answer: (C)

A floating rate system implies that exchange rates are determined by the market forces of supply and demand rather than being fixed or pegged to another currency or a set value. In such a system, central banks can influence exchange rates through monetary policy, which includes setting interest rates and utilizing open market operations. This means that while exchange rates fluctuate based on economic conditions and investor sentiment, central banks can have a target level or range in mind for the exchange rate, which they may attempt to support through their policies.

This understanding highlights that a floating rate does not automatically mean that the exchange rates are entirely left to the whims of the market; rather, they can have guiding targets or ranges, reflecting the active role of central banks in attempting to manage their national currencies.